Apple's Flashy Music Margins

JUNE 28, 2011   THE WALL STREET JOURNAL

By MARTIN PEERS

Apple's success in digital music is no flash in the pan.

Reuters

Google andAmazon.com, each recently unveiling virtual lockers for digital music, face big obstacles taking on Apple. Most obviously, that's because of its already dominant position through iTunes. Less obvious: Apple's approach is potentially cheaper for consumers and much more lucrative for the company. Apple is effectively making a bet on the falling cost of flash memory, while the Google and Amazon efforts expose consumers to the rising cost of Internet bandwidth.

Google's and Amazon's services involve users streaming content from cloud-based servers to their devices. That allows users to listen to their music collection from their PCs at work, for instance, or on a mobile device with a Web connection. But with wireless operators introducing usage-based pricing for data, frequent streaming could add to cellphone bills. AT&T's wireless service, for instance, charges $25 a month for two gigabytes of data and $10 for each additional gigabyte.

Apple's strategy, on the other hand, rests on consumers storing their content locally on their devices. Its new iCloud service allows consumers to easily sync their music collections to any of their Apple devices. Aside from the initial sync, a Web connection isn't necessary.

This new service may prompt consumers to get the most storage possible on their various devices to ensure they have the space to hold everything. That means big profits for Apple, because it sharply marks up the cost of the NAND flash memory-storage chips used on its mobile devices.

Consider: Apple charges $100 more for an iPad or an iPhone with 32 gigabytes of storage than for one with 16 gigabytes. But that extra 16 GB of NAND flash likely costs Apple around $15. Gartner's research director for NAND flash and solid state drives, Joe Unsworth, estimates Apple pays about 90 cents for a gigabyte of NAND.

Admittedly, a 64 GB iPad is only $100 more than a 32 GB device, suggesting a slightly lower NAND markup. Even so, Apple's retail prices imply gross margins as high as 85% on NAND, compared with its overall gross margin of 41.4% in the March quarter. Moreover, NAND prices are likely to fall sharply, as new flash fabrication facilities come on line. Mr. Unsworth estimates the price of NAND fell about 18% in 2010 and predicts it will drop another 30% this year, 36% next year and 39% in 2013.

Bandwidth costs, however, are likely to go up, at least in wireless where capacity is scarce. And while consumers can use Wi-Fi networks to avoid cellular bandwidth charges, streaming via Wi-Fi may eventually come at a cost, too. Landline-based broadband operators will likely eventually introduce usage-based pricing.

For Google and Amazon, taking a bite out of Apple's market share in music could be painful.

Write to Martin Peers at martin.peers@wsj.com